After months of closed door negotiations, it appears that the future of domestic flood insurance has finally reached a conclusion. Laura Oliver provides an update and questions what this means for commercial properties.

Last summer we reported on the storm that was brewing between insurers and the government over the future of flood insurance1. The Statement of Principles on the Provision of Flood Insurance, which committed insurers to providing flood insurance as widely as possible, was due to expire in June of this year, 2013. There was a real possibility that, once the Statement expired, many residential property owners in high risk areas would be unable to insure their properties.

Over the past year, negotiations between insurers and the government have been alternately described as “constructive”, “arduous and difficult” and “urgent”. As the June deadline approached, public and political interest increased and Labour’s shadow environment secretary called for the government to “get a grip on flood insurance” and “get a deal”.

In May we had a stay of execution (of sorts) when the Association of British Insurers agreed that its members would voluntarily continue to offer flood insurance to all homeowners until the end of July. Finally at the end of June, after months of closed door negotiations, the ABI and the government announced a Memorandum of Understanding to safeguard the affordability and availability of domestic flood insurance. The Memorandum provides for the current agreement (which covers homes and small business premises) to continue until a new scheme, Flood Re, is established. This is expected by June 2015.

Flood Re will create a dedicated fund to cover the cost of flood claims from high risk homes by collecting an annual levy of £180 million from member firms. The cost of the levy will be passed on to all households through increased insurance premiums and is expected to be around £10.50 per household.

Households with high flood risk will then pay a premium based on council tax banding, up to a maximum limit. Band H properties, properties built after January 2009 and “genuinely uninsurable properties” will be excluded from Flood Re. The insurance industry will also ensure a standard flood excess of between £250 and £500.

The aim is for Flood Re to cover the vast majority of flood claims, but the insurers’ aggregate annual liability will be capped at a monetary equivalent to a 1 in 200 year loss scenario (i.e. the cost of claims in the worst 0.5% of years). If claims exceed this level, the government would act as an insurer of last resort.

In a statement, Otto Thoresen, the ABI’s Director General explained that:

“Getting to this stage has required compromise by both sides and there remain issues that need to be overcome. For Flood Re to be established successfully there needs to be an unprecedented level of partnership between the government and the industry. But insurers and the government are now working towards a shared vision.”

Although there is a long way to go before Flood Re is up and running, the Memorandum should be welcomed by all home owners. Left to the free market, it was probable that insurance would have become difficult to obtain or prohibitively expensive. That would have made selling high risk properties problematic as lenders will not lend against uninsurable properties.

As for commercial properties, the issue is not quite as straightforward. The Statement only ever covered small business premises. Flood Re will not even do that. In the commercial sector the cost and availability of flood insurance is subject to a market-based approach. Industry experts have recently expressed concern that with increased incidences of flooding (2012 was the wettest year on record in England and Wales) and without intervention from government, commercial flood insurance could become a real area of concern for the commercial real estate industry.

As part of its insurance campaign to ensure the availability and affordability of flood insurance for commercial properties, the BPF have therefore called on the government and other responsible bodies to provide effective flood defences and other measures to reduce the risk of flooding, and the damage it causes. The Memorandum will, at least, provide some comfort on that score as the government has agreed to provide a letter of comfort committing to agreed levels of flood defence expenditure.

As the BPF points out, if flood insurance were to become unavailable or prohibitively expensive, landlords of commercial properties would risk breaching their insurance covenants, developers would struggle to develop and properties could not be sold. “This would have serious and wide ranging ramifications for our industry2.”

The Memorandum should therefore be seen as a positive outcome for commercial properties as well as their domestic counterparts. However, cynics will note that improved flood defence measures were also promised by the government when the Statement was agreed in 2000.

Need to know:

  • The Statement of Principles on the Provision of Flood Insurance was agreed in 2000. It committed the insurance industry to providing affordable flood cover for domestic and small business premises, but in return the government committed to ensuring that flood risk was appropriately managed and that long-term measures were taken to reduce flood risk.
  • The Statement does not cover commercial properties other that those qualifying as “small business premises”.
  • The Statement has been criticised as a commercial disadvantage for the insurers who signed up to it as new entrants to the insurance market do not need to adhere to it and are therefore able to avoid offering insurance in high risk areas. Under a new Memorandum of Understanding the government has agreed to introduce legislation which will compel all participants in the home insurance market to contribute to Flood Re.
  • The Statement was due to expire at the end of July, but ABI members will voluntarily continue to meet their commitment to offer flood cover to existing customers under the Statement until Flood Re is up and running – which is expected to be by June 2015. Although the Memorandum is unclear on this point, it seems probable that “small business premises” already insured under the Statement will continue to be covered during this interim period.